Taking Stock: Success Calls, But The Price Is Steep

Nortel may find that sales drop off in the second half of the year

Given the stock-price increases of companies such as Juniper Networks, Lucent Technologies, and Nortel Networks, you might think that phone companies are buying equipment left and right. Cisco Systems has been the laggard in this market because its stock has appreciated 43% year to date through June 18. Lucent and Nortel are up 69.1% and 92.6%, respectively, for the same period. The big winner has been Juniper Networks, up 104.4%.

Lucent is on track to sell about $8.5 billion in equipment and services in fiscal 2003, ending Sept. 30. That's down about 30% from its $12.3 billion in sales in fiscal 2002. The company depends on North American sales, which have remained lackluster. Lucent expects to finish its restructuring by the second half of the year, which should help its income statement and balance sheet. Wall Street consensus fiscal 2003 and 2004 earnings-per-share estimates are -32 cents and -1 cent, respectively. In other words, you have to wait until fiscal 2005 to get to profits.

OK, maybe Lucent isn't a good example. Nortel must be doing better to justify the big jump in its stock price, right? It's been reducing costs, so expenses have been in line with revenue. But with its dependence on China and the problem that country is having with SARS, Nortel may see equipment sales drop off in the second half of 2003. Also, though Nortel insists the market is moving toward its vision of packet-based core network technology, migration isn't likely to be quick. Wall Street earnings-per-share estimates for calendar 2003 and 2004 are 4 cents and 10 cents, respectively. At a share price of $3.10 (as of June 18), this represents whopping price-to-earnings multiples of 75 and 30, respectively.

Hey, those are just the stodgy equipment vendors. Innovation is at Juniper Networks, you say, and its fundamentals must be rocking. Well, not really. Juniper's management has stated that the upcoming quarter is on track to meet its prediction of flat to slightly higher sales. China and SARS may hurt Juniper, too--a much bigger impact now that the international market, including Asia, represents more than 60% of its total sales. Estimated earnings per share for calendar 2003 and 2004 are 8 cents and 15 cents, respectively. This puts price-to-earnings multiples at 160 and 85, respectively, at a share price of $13.90 (as of June 18).

So if fundamental demand hasn't picked up dramatically, what's caused these share prices to increase? The short-term outlook on investing in technology has shifted from dramatically negative to dramatically positive in the last few months. When you have such a huge change in investor sentiment, short-term demand for stock can cause substantial pickup in pricing. This can be exaggerated by the fact that Lucent and Nortel were selling at less than $2 a share at the beginning of the year. A 5-cent price shift on Lucent when it was trading at $1.26 at the beginning of the year was almost a 4% jump in the stock price.

These companies aren't likely to grow very rapidly in the near term, but survival seems to be rewarded in this market environment. Maybe some forgetful technology investors are looking at price-to-sales ratios again since price-to-earnings multiples are astronomically high or nonexistent.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. Bay Isle has no affiliation with nor does it receive compensation from any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one of more of these companies at any given time.

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